Bad Debt: Write-Offs, Provisions and the Impact on Company Accounts

What counts as a bad debt?

A bad debt arises when a company concludes that an amount owed by a customer or counterparty will not be recovered. This may follow insolvency of the debtor, a disputed invoice that has been settled for less than the full amount, or prolonged non-payment after reasonable collection efforts have been exhausted.

Companies should distinguish between a specific provision — set against a named debtor where recovery is doubtful but not yet certain — and a write-off, which removes the debt entirely from the ledger when recovery is no longer realistic. Both reduce profit in the period the decision is made.

VAT bad debt relief

When a UK VAT-registered business has accounted for output VAT on a supply but the customer has not paid after six months from the due date (or the date of supply if no payment terms were agreed), the supplier may reclaim the VAT from HMRC under Bad Debt Relief. The debtor, if VAT registered, is simultaneously required to repay any input VAT it originally reclaimed on that invoice.

To claim the relief, the debt must be written off in the company's VAT account and the business must have held the supply for the minimum period. Detailed record-keeping is essential in case HMRC requests evidence during a VAT inspection.

Corporation tax treatment

For corporation tax purposes, a specific bad debt provision is generally deductible once the debt is genuinely doubtful and the provision is made in accordance with generally accepted accounting practice. A general provision — for example, a blanket percentage applied to all debtors — is not normally deductible. The timing of deductibility should be confirmed with your accountant, as HMRC guidance on provisioning can differ from accounting standards in certain scenarios.

Impact on working capital and lending

Rising bad debts or a growing provision erodes net current assets and reduces the quality of the trade debtors balance that a lender might consider when assessing invoice finance or a working capital facility. A lender may exclude aged or disputed debts from an eligible debtors pool, which directly reduces the amount available to draw under a facility.

Monitoring debtor days regularly and maintaining a credit control policy are the most effective ways to keep bad debt exposure contained.